Dividends Are Only Part of the Story

Don't just chase high dividends, says Roger Conrad.
Investors need to be very cautious when choosing among companies with high
yields.

Nancy Zambell: My guest today is Roger Conrad, and he is the
editor of Utility Forecaster, Canadian Edge, and many other
publications too numerous to count. Roger, thanks for joining me.

Roger Conrad: Thanks, Nancy.

Nancy Zambell: I've noticed that the utilities have been
rallying quite a bit. You wrote about that recently in one of your newsletters,
as well as about master limited partnerships.

Roger Conrad: At the end of last year, there was a lot of
worry about the dividend tax rate and the fiscal cliff, and we saw a lot of
profit-taking across the board, and underperformance.

There was worry that the top rate might go to 39% or even 40%-well over 40%
for higher income brackets. There was something of a worry that a higher rate
would set off a real selling wave, so a lot of investors tried to get out ahead
of that.

As a result, we had some fairly dramatic underperformance at the end of the
year. That included the master limited partnerships, which were never targeted.

But I think a lot of people were concerned that because of the accumulated
capital gains on MLPs that they would be paying a pretty high tax rate. So, what
we saw this year, I think, is in some ways a reversal of that, because we did
have an eleventh-hour deal on the deficit.

Nancy Zambell: Right.

Roger Conrad: 15% to 20% tax rates were not nearly as much
as a lot of people had feared, and I think part of that (rally) is the reaction
to that. I do think that people need to be fairly discriminating toward their
dividend-paying stocks as we go in. So don't be completely taken in by this big
rally that we've had.

Nancy Zambell: So no more "just throw at the dart board,"
right?

Roger Conrad: Yes, I think that what we're seeing here. And
one of the things that a lot of people haven't really been talking about is what
impact austerity will have on the economy.

We've certainly seen in Europe a lot of very turbulent activity-credit
markets, and companies unable to borrow, earnings dropping, and dividends being
cut. And of course, a lot of those economies are still running very, very slowly
as they try to get their deficits under control.

While the action here hasn't been nearly as dramatic-with the Social Security
tax and some of the spending cuts and the raising of rates-there is some
austerity coming down the pike. And the economy hasn't been growing that fast.

In the last two or three years, we've seen fairly positive action for
dividend-paying stocks across the board, but some of them are stumbling because
of economic trends. And the more exposed companies have been-to commodity
prices, or to something else that's economically sensitive-the more vulnerable
they've been to this type of action.

Even as dividend-paying stocks as a whole have been going up, some individual
companies have more or less crashed and burned. Investors today follow momentum,
probably about as much as I've ever seen. When something's rising, everybody
wants to own it. So you see them casting valuations aside and bidding things up.

But it works the other way, too. When you do have a company that stumbles, it
can take a bite out of your portfolio.

Nancy Zambell: Sure. Now we're in the midst of earnings
season, and they are sort of mixed with the dividend-paying companies.

Roger Conrad: That's correct, and it's really part and
parcel of the broader economic context. One area that I think has kind of snuck
up on people-myself included-has been the rise of price differentials in oil
across North America.

There's a global price, Brent crude, which has been trading at a fairly
substantial premium to West Texas Intermediate crude, considered the benchmark
for the United States. The reason is inadequate pipeline capacity to bring oil
from the Oklahoma hub down to Gulf Coast refineries, where it can be
exported.

And that's where you have the arbitrage in pricing. You've had inadequate
capacity there. But if you look around where we're seeing a lot of the new oil
being produced-the Bakken region, Canada, western Texas-you don't have those
pipelines that you've historically had.

You have a lot of oil coming out. It's a huge boom. I think it's going to
continue for a long time to come. But right now companies are shipping it any
way they can. Some are doing it by rail, which has become a really big business.
But the bottom line is, the pipeline capacity is not there.

So you have high prices, oil companies producing oil and paying dividends,
but they're selling their product for $30, even $40, less than benchmark prices.
So that puts pressure on dividends.

It's one of those issues that we're really watching, because if cash flow
really does drop off for some of these companies, the dividends are one lever
that management pulls. And even though you can have a company that's still
pretty solid, it's paying you less, and more than likely the share price is
going to come down as well if there's a cut.